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Is Britain’s Economy Slowing Down?

5 minute read
Adam Smith/London

Before he took over as British Prime Minister last month, Gordon Brown’s speeches often included a familiar refrain. Britain’s economy, the then-Chancellor of the Exchequer would thunder, boasted sustainable growth — averaging almost 2.9% over the past decade, modest interest rates and low inflation. “Of all the major economies — America, France, Germany, Japan,” Brown boasted late last year, “Britain has enjoyed the longest postwar period of continuous growth.”

He couldn’t claim all the credit, of course; the strong global economy that spurred Britain’s economy during his 10 years as Chancellor had little to do with Brown, for one thing. But Britain’s longest-serving finance minister since the 1820s is owed at least some of the plaudits. For example, his bold decision to grant independence to the Bank of England in 1997 separated politics from the setting of interest rates, helping raise confidence in the U.K. economy and providing a backdrop for stable growth.

It’s not surprising, then, that the man picked in June to replace Brown — a dependable, gaffe-free Scot — as Chancellor signaled little in the way of change. But if Alistair Darling (no less dependable, gaffe-free, or Scottish) is unlikely to tinker too much with the Treasury, both men must be hoping the British economy remains just as reliable. And, right now, there’s cause for concern. Rising gas prices kept inflation at 2.4% in June, above the government target of 2% and the E.U. average of 2.1%. Desperate to keep a lid on prices, the Bank of England pushed up interest rates earlier this month to 5.75%, a six-year-high and the fifth rise in less than a year. Economists expect the Bank to further nudge up rates to 6% in the coming months.

You can almost hear Britain’s consumers groan. With household debt in the U.K. more than doubling over the last decade to $2.6 trillion, and Britons’ rate of saving at its lowest level since the 1960s, rising interest rates will hit pocketbooks hard. The CBI, a business lobby group, expects consumer spending to grow 2.8% this year. Next year, it says, that figure could slip to 2.1%. Economic growth won’t escape unharmed, either. The threat of rising rates triggering a downturn is “greater today than it has been in the 10 years Labour have been in power,” says Adrian Cooper, managing director of consultants Oxford Economics. So while economists are penciling in growth of 2.7% this year, expansion in 2008 could tumble to 2% says Karen Ward, U.K. economist at HSBC in London. “The new Chancellor,” Ward adds, “is going to have to modify the opening line of his speech.”

The new Chancellor, of course, has few policy levers through which to intervene — it’s up to the Bank of England to decide when inflation has been tamed by changes to the cost of borrowing; certain taxation levels for the next couple of years were set last March, and growth in government spending until 2011 has already been capped. The good news for Darling: Rising interest rates seem to be cooling Britain’s housing market, where low-cost credit and a limited supply of homes have sent house prices skyward in recent years. The value of the average home reached $401,000 in May according to Halifax, a mortgage provider. That’s almost three times the average in 1997. But with new buyers treading carefully, house prices rose by just 2% in the second quarter of this year, below the increase of the previous two quarters. Housing price inflation rates are expected to fall further in the coming months, economists say.

Despite signs suggesting a cooling off, there are good reasons not to fear a housing market crash. By the time house prices tanked in the early 1990s on the back of a boom in previous years, interest rates had hit an eye-watering 15%, analysts at Bank of America point out in a recent note. That’s a long way off today’s level. And unemployment neared 10% in 1991, triggering record numbers of home repossessions. With today’s jobless rate at 5.4%, comfortably below the level in Europe’s other major economies, the labor market offers a good deal more support.

That’s not to say businesses aren’t feeling the pinch. U.K. listed firms issued more profit warnings in the first half of this year than in any same period since the dotcom blowout. Even in the City, London’s fiercely competitive financial center, the number of new jobs is set to slip by two-thirds this year, according to the capital’s Centre for Economics and Business Research. But despite the doom and gloom, there’s still room enough for specialist sectors to grow handsomely. London’s leading share of international markets means Britain’s financial services sector should still grow by 4.7% this year, according to Ernst & Young. And that will surely make it into the Chancellor’s speech.

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